DBRS Downgrades McKesson to BBB (high) and R-2 (high) Following Acquisition of Celesio

DBRS has today downgraded the Issuer Rating and Senior Unsecured Debt rating of McKesson Corporation to BBB (high) from A (low) and the Commercial Paper rating of McKesson Canada (collectively, McKesson or the Company) to R-2 (high) from R-1 (low); the trends are Stable. This action follows the Company’s acquisition of Celesio AG (Celesio) and its announced financing intentions. DBRS has removed the ratings from Under Review with Negative Implications.

On October 24, 2013, DBRS placed McKesson’s ratings Under Review with Negative Implications subsequent to the Company’s announcement that it had signed an agreement to acquire a majority stake in Celesio. The original agreement was conditional upon McKesson reaching 75% ownership of Celesio on a fully diluted basis. On January 23, 2014, the Company announced that it had reached an agreement to acquire over 75% ownership of Celesio on a fully diluted basis, but DBRS maintained the Under Review with Negative Implications on McKesson’s ratings as no final financing intentions were released at that time.

McKesson agreed to acquire the entire holding in Celesio of Franz Haniel & Cie, GmbH, as well as convertible bonds from Elliott, which represents over 75% of the total outstanding shares on a fully diluted basis for approximately $5.1 billion. The acquisition was initially funded with $5 billion from the Company’s bridge facility as well as cash on hand. DBRS expects McKesson will repay the $5 billion bridge facility using approximately $4.1 billion in new senior unsecured notes, cash on hand and the potential use of the Company’s accounts receivable sales facility.

On February 28, 2014, McKesson launched a voluntary public takeover offer for the remaining outstanding shares of Celesio. McKesson expects to fund the acquisition of the remaining issued and outstanding share capital of Celesio with a combination of operating cash flow, cash on hand and, depending on the timing of such acquisition, other sources of short-term liquidity.

In terms of operations, McKesson has stated that it expects to realize annual synergies in the $275 million to $325 million range by the fourth year following operational control. DBRS believes at least part of such synergies will be achieved by leveraging increased scale, supply chain and logistics expertise and sourcing capabilities, as well as IT and back office optimization. DBRS expects McKesson will undertake material deleveraging in the near to medium term, by repaying upcoming maturities. That said, DBRS believes that leverage will remain significantly higher than previous levels for an extended period of time, but expects sufficient deleveraging to return credit metrics to a level considered acceptable for the new BBB (high) rating category by mid F2016.

In its review, DBRS focused its analysis on (1) the business risk profile of Celesio, including the risks associated with integration and achieving potential synergies; (2) the immediate impact of the acquisition on the financial risk profile of McKesson; and (3) the Company’s longer-term business strategy (including growth plans) and financial management intentions.

Despite the number of benefits the acquisition will bring, DBRS believes that McKesson is best positioned in the BBB (high) rating category, with a Stable trend, based primarily on the material increase in leverage and necessary deleveraging for an extended period of time, as well as risks associated with its entry into a new operating region, with fully realizing expected synergies.

DBRS ANALYSIS
(1) Business Risk Profile
The acquisition of Celesio, a wholesale and retail company and provider of logistics and services to the pharmaceutical and health-care sectors provides McKesson with a presence in Europe and certain emerging markets. Celesio’s approximately EUR 21 billion in sales (for the last 12 months ended Q3 2013) will benefit McKesson’s overall scale and geographic diversification, the benefits of which are partially offset by exposure to new operating regions with different regulatory environments. Overall, DBRS views the impact of the acquisition on the Company’s business risk profile to be moderately positive.

(2) Financial Risk Profile
In terms of McKesson’s financial profile, DBRS estimates the total acquisition price values Celesio at approximately $8.9 billion (including approximately $2 billion of assumed debt, representing an EBITDA multiple of nearly 12x) resulting in a meaningful increase in the Company’s leverage to a level that is no longer consistent with DBRS’s previous A (low) rating. At Q3 F2014 (i.e., pre-acquisition), McKesson had balance sheet debt of approximately $4.9 billion and EBITDA of approximately $3.1 billion, resulting in lease-adjusted debt-to-EBITDAR of 1.88x and lease-adjusted EBITDA coverage of 9.98x.

Pro forma F2014, subsequent to the Celesio acquisition and the related financings (i.e., post-acquisition), DBRS estimates that McKesson will have balance sheet debt of approximately $11 billion, including assumed debt, and adjusted EBITDA approaching $4 billion, resulting in lease-adjusted debt-to-EBITDAR of nearly 3.1x. The Company is nevertheless expected to continue to generate healthy levels of free cash beginning in F2016 (at least a portion of cash flows generated in F2015 will be used to acquire the remaining outstanding Celesio shares) based on operating cash flow in the $3.5 billion to $3.7 billion range before changes in working capital, capex in the $450 million range and dividends of over $200 million.

(3) Outlook
DBRS recognizes that McKesson possesses the ability to deleverage at a good pace going forward, based on its sound free cash flow generation, of which nearly $2 billion will be available for debt repayment beginning in F2016. DBRS believes the Company will use this ability to materially reduce debt levels over the medium term, which, combined with growth in earnings, will result in improved credit metrics. Specifically, DBRS expects lease-adjusted debt-to-EBITDAR to decline toward 2.5x and lease-adjusted EBITDA coverage to improve toward 8.5x by mid F2016, timing and levels considered acceptable for the BBB (high) rating category.

DBRS’s expectation for deleveraging, combined with the opportunity for growth and enhanced diversification, leads DBRS to believe that McKesson is best positioned in the BBB (high) rating category with a Stable trend. Should the Company not deleverage to indicated levels within an acceptable time frame and/or experience weaker operating performance than expected, its credit ratings could be pressured.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.